Harris Corp. (HRS), at recent prices in the 49 area, is attractive as a GARP investment in the Communications Equipment sector. Despite 5 year revenue growth of 10.4% and 5 year EPS growth of 23%, the company trades at a TTM P/E of 9.9. Because more than half of its revenue is dependent on the US government, it has been punished as a defense contractor. However, HRS is expanding outside of the government arena and has ambitious plans for future growth.
I got the prospect from a screen I created at StockScreen123. The parameters: Price/Projected 5 year average earnings between 5 and 15, or Price/Sales between .6 and 1, or Price/Tangible Book between 1 and 2; and Debt/Equity less than 35%, or EPS/Cash Flow less than 65%, or Current Ratio between 1.5 and 3.
The thinking is, to include a large number of stocks that fall within a golden mean on any one of three value parameters, then qualify them for survivability, based on any one of three financial strength metrics. Stocks that pass the screen are then ranked by 5 year growth in Cash Flow, and the top 20 presented as candidates. The screen performs well on backtests, returning 12.2% over the past ten years. This article presents the results of research on HRS conducted prior to investing.
From the 10-K:
Harris Corporation, together with its subsidiaries, is an international communications and information technology company serving government and commercial markets in more than 150 countries. We are dedicated to developing best-in-class assured communications® products, systems and services for global markets, including RF communications, government communications and broadcast communications.
Sales to U.S. Government customers, including the DoD and intelligence and civilian agencies, as well as foreign military sales through the U.S. Government, whether directly or through prime contractors, were 76 percent of our total revenue in fiscal 2010 compared with 79 percent in both fiscal 2009 and fiscal 2008. No other customer accounted for more than 2 percent of our total revenue in fiscal 2010.
The company is expanding beyond this core market into adjacent areas, both by acquisitions and by new product development. The slides from their 2011 Analyst Meeting are available on the website, and provide detailed insight into the company's operations and plans for future growth.
Growth by Acquisitions
Growth is the goal, and acquisitions are a primary driver. Recent acquisitions: Crucial Security (April 2009), M/A-COM (May 2009), Patriot Technologies (November 2009) SignaCert (May 2010), CapRock Comm's (July 2010), and Core 180 (March 2011).
Two additional acquisitions - Schlumberger GCS and Carefx - are expected to close in April this year.
The history of profitable growth demonstrates that acquisitions to date have been well thought out and effectively integrated.
The R&D budget for 2010 was 1 billion, or 19% of revenues. 721 million was funded by the U.S. government. The resulting technology is available for use in commercial markets.
Access to Credit Markets
HRS is rated BBB+ by S&P and Baa1 by Moody's. A 400 million bond offering placed in December 2010 carries a coupon of 4.4000% and trades to yield 4.283%.
The ratio of earnings to fixed charges stood at 11.82 as of 12/31/2010.
There are no major maturities until 2015. There is 720 million available under a 750 million revolver which expires September 2013.
Cash Flow Deployment
The company has steadily increased cash from operations over the past three years; 555.5, 666.8, and 802.7 million, successively.
For fiscal 2011, projections call for cash flow of $800-850, to be deployed on capex, R&D, dividends, acquisition funding, and buybacks.
For 2012-2014, cash flow in excess of 900 million annually is envisioned. After funding R&D, capex, a dividend payout > 20% of earnings, and buybacks in the 200 million area, the remaining flow will permit the accumulation of excess cash.
A Philosophical Digression
There seems to be a trend developing, for corporate management to look out multiple years into the future when doing presentations. David Speer, CEO at Illinois Tool Works (ITW) is now talking about 2015. James B. Flaws, CFO at Corning (GLW) is talking about growing from 6 billion now to 10 billion of revenues in 2014. And Howard Lance, HRS CEO, is willing to hold out 7.00 per share for fiscal 2014 as an aspiration.
That's quite a change from early 2009, when nobody had any visibility. That raises the question: how far into the future can management see? How far into the future can anyone see? I'll leave Nostradamus out of the discussion.
Analysts, when preparing a DCF valuation, typically project cash flow for five years forward, to which they append a 1 or 2% growth rate in perpetuity. Nothing lasts forever. The bust of Ozymandias lies face down in the dust.
In 2009, I hazarded a guess that economic life would go on, and eventually return to normal. Perspicacious, in retrospect. Two years later, my guess is that things will continue along their current trajectory, which will bend in the direction of mean reversion.
The company's fiscal year ends 6/30. Projecting 2012 EPS at 5.00, I apply a P/E multiple of 12.5, arriving at target price of 62, by the end of calendar 2012. From a recent price of 49, the implied annualized appreciation is 14%, to which can be added a 2% dividend, for a total of 16%.
Ben Graham suggested that conservative investors buy well financed stocks at prices below 15 X 5 year average EPS. HRS trades at a P/E5 of about 13.5, well within Graham's rule of thumb. Investors buying at today's price have a reasonable expectation of receiving a 2% dividend and eventual share price appreciation. I'm investing on the basis that annualized returns on the order of 16% are likely over the next 2 years.
Results should be monitored on a quarterly basis, with special attention to the handling of debt related to acquisitions and the degree of success in diversifying away from dependence on the U.S. government as the primary customer.
The stock is optionable, to include LEAPS, and implied volatility stands at 26.3%. A diagonal spread strategy makes sense to me in this situation.
I was able to buy the HRS Jan 2012 35.0 call at a time cost of .80. That is, I paid 14.60 with the stock trading at 48.80. At the same time I sold the HRS Aug 2011 55.0 call for 1.10, more than covering the time cost of the long leg, and maintaining exposure to 6.20 of the upside. Here are three possible outcomes: